Yesterday: Market Panic In The Morning and Euphoria In the Afternoon

Yesterday saw pure market panic in the morning followed by euphoria in the afternoon when word leaked out on CNBC TV that Treasury Secretary Hank Paulson and Fed Chair Ben Bernanke would meet with Congressional leaders of both parties at 7 p.m. last night.

You would never guess what actually happened in the meeting from the positive statements made afterward around 8:20 p.m.  No plan was presented other than in the most general terms to have the federal government acquire distressed assets of financial institutions.  No cost estimate was presented.  When pressed, Paulson and Bernanke said "hundreds of billions."  When asked how many hundreds of billions, they just repeated themselves, "hundreds of billions."

House Speaker Nancy Pelosi (D-CA) reportedly expressed displeasure with the Administration's attempt to get Democrats "to pick up the bloody knife."  In other words, she saw President Bush's financial deregulation as having led to the murder of the U.S. financial system.  Outside of the meeting and in private, her staff charged President Bush with "taking the referees off the field."

Senator Richard Shelby (R-AL), the ranking Republican on the Senate Banking Committee, attended last night's meeting, but he declined to appear on camera because he was not satisfied that the taxpayers are being protected.  He has been a lone voice in the wilderness for years on the dangers of the financial excesses he saw.  Republican leaders made supportive statements, but they know they face opposition from colleagues who share Senator Shelby's concerns.

There was discussion in the meeting by members of Congress about the political dilemma they face of appearing to bail out Wall Street while leaving Main Street unprotected.  Mr. Paulson responded that if they didn't save Wall Street, Main Street would pay the price as the ability to get credit disappeared and the economy nosedived.  House Financial Services Chair Barney Frank (D-MA) demanded that the Administration deliver a bailout for homeowners facing foreclosure of similar size to the one proposed for financial institutions.  Now that the government has taken over Fannie Mae and Freddie Mac, mortgage forebearance is directly within Administration control.

Alan Greenspan's name came up on the lips of an unnamed member of Congress for failing to stop the decline in mortgage lending standards and for supplying too much liquidity.  There is plenty of blame to go around, and the members realized that any public finger pointing would just make matters worse.  Therefore, nearly all of them linked arms and supported the very vague proposal offered by Secretary Paulson.

Hearings will be held by Senate Banking and by House Financial Services next week, which will address pointed questions to Mr. Paulson and Mr. Bernanke.  How is the government going to decide what institutions and what impaired assets qualify for purchase and at what price?  Will the taxpayer retain ownership rights or warrants in hope of recouping up front costs?  Is there any limit on how much liability will be taken on by the taxpayers?  Who is going to manage this asset workout-- by far the largest in history?  Is Treasury or a revived Resolution Trust Corporation (used in the S&L crisis of the 1990s) or a revived Reconstruction Finance Corporation (used in the Depression) going to hire the managers of recently failed financial institutions to clean up the mess they themselves created?  When are we going to modernize our 19th Century financial regulatory system, and what should it become?

It would be fantasy to think straight answers will be forthcoming to these difficult questions.  Market confidence depends upon maintaining appearances.  That may be, but our children will spend most of their lives working off the mountain of debt that is being incurred.